10.0% 11.1% 9.2% 4.4% 7.4% 12% 10% 8% 6% 4% 2% $.59 $.79* $.63 $.30 $.54 $.80 $.70 $.60 $.50 $.40 $.30 18.1% 19.9% 13.7% 5.7% 9.3% 20% 15% 10% 5% 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 Net Margin Net Income Per Share, Diluted * Excludes cumulative effect of change in accounting principle of $.03. Return On Stockholders Equity CONSOLIDATED HIGHLIGHTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 2003 2002 CHANGE Operating revenues $5,937 $5,522 7.5% Operating expenses $5,454 $5,105 6.8% Operating income $483 $417 15.8% Operating margin 8.1% 7.6% 0.5pts. Net income $442 $241 83.4% Net margin 7.4% 4.4% 3.0pts. Net income per share basic $.56 $.31 80.6% Net income per share diluted $.54 $.30 80.0% Stockholders equity $5,052 $4,422 14.2% Return on average stockholders equity 9.3% 5.7% 3.6pts. Stockholders equity per common share outstanding $6.40 $5.69 12.5% Revenue passengers carried 65,673,945 63,045,988 4.2% Revenue passenger miles {RPMs} (000s) 47,943,066 45,391,903 5.6% Available seat miles {ASMs} (000s) 71,790,425 68,886,546 4.2% Passenger load factor 66.8% 65.9% 0.9pts. Passenger revenue yield per RPM 11.97 11.77 1.7% Operating revenue yield per ASM 8.27 8.0 2 3.1% Operating expenses per ASM 7.60 7.41 2.6% Size of fleet at yearend 388 375 3.5% Number of Employees at yearend 32,847 33,705 (2.5)% Southwest Airlines Co. is the nation s low-fare, high Customer Satisfaction airline. We primarily serve short- and medium-haul city pairs, providing single-class air transportation which targets business and leisure travelers. The Company, incorporated in Texas, commenced Customer Service on June 18, 1971, with three Boeing 737 aircraft serving three Texas cities Dallas, Houston, and San Antonio. At yearend 2003, Southwest operated 388 Boeing 737 aircraft and provided service to 59 airports in 30 states throughout the United States. Southwest has one of the lowest operating cost structures in the domestic airline industry and consistently offers the lowest and simplest fares. Southwest also has one of the best overall Customer Service records. LUV is our stock exchange symbol, selected to represent our home at Dallas Love Field, as well as the theme of our Employee and Customer relationships.
FREEDOM Americans didn t just invent the airplane, we invented the airline as well. Back in 1914, a few bold travelers flew on the Airboat Line between Tampa and St. Petersburg. Today, Southwest Airlines gives Americans the freedom to fly from coast to coast, including Tampa/St. Petersburg. In February 2003, Southwest was named the Most Admired Airline for the second straight year in FORTUNE magazine. In June, we announced that our current and future f leet of Boeing 737-700s will be outfitted with fuel-saving, performance-enhancing Blended Winglets. In August, the Bureau of Transportation Statistics announced that Southwest carried more domestic originating passengers in May than any other airline, marking the first time a low-fare airline has topped those monthly rankings. In October 2003, we announced service, beginning in May 2004, to Philadelphia, the city that freedom built. As we look back on our 31st consecutive profitable year, we are once again proud to say, You are now free to move about the country.
2 Southwest Airlines Co. 2003 Annual Report To Our Shareholders: Just as promised in our 2002 Annual Report, in the year 2003 Southwest Airlines kept MOVING AHEAD. While the airline industry, as a whole, reported more than $5 billion (excluding special items) in 2003 losses: 1. Southwest produced its 31st consecutive year of profitability, an airline industry record that has also generated unprecedented airline industry job security and exceptional Profitsharing for our marvelous Employees, as well as exceptional investment returns for our Shareholders, including Employee-Shareholders. 2. Southwest s annual profits increased from $198 million in 2002, excluding special items ($241 million, including special items), to $298 million, excluding special items ($442 million including special items, such as industrywide government war relief grants). 3. Southwest expanded its fleet by a net of 13 new 737-700s and increased our Available Seat Miles by 4.2 percent. 4. Southwest continued to equip our new aircraft deliveries, and to refurbish our existing fleet, with our fresh and most attractive Canyon Blue aircraft livery; all leather interiors in Canyon Blue and Saddle Tan; new design seats affording superb personal comfort; and aesthetic Blended Winglets, which improve aircraft performance by extending range, saving fuel, and reducing engine maintenance costs and takeoff noise. 5. Southwest retained its leadership in Customer Satisfaction, again receiving the fewest Customer complaints per 100,000 Customers carried, as reflected in DOT statistics compiled from reports furnished to DOT by the largest domestic air carriers. 6. Southwest was selected: In FORTUNE magazine, as one of our nation s Most Admired Companies In Business Ethics magazine s listing of the 100 Best Corporate Citizens in America In HISPANIC magazine s listing of the 2003 Hispanic Corporate 100 The Best Low Cost Airline at the 2003 Official Airline Guide Airline of the Year awards By Air Transport World magazine as its Airline of the Year By Inside Flyer magazine as having the Best Customer Service, Best Bonus Promotion, and Best Award Redemption of any frequent flyer program (Southwest s Rapid Rewards) As featured airline in the A&E Network series AIRLINE For Global Finance magazine s Experts List of the World s Most Socially Responsible Companies. We intend to keep MOVING FURTHER AHEAD in 2004, expanding our fleet by a net of 29 new 737-700s and our Available Seat Miles by almost eight percent, while utilizing our proportionally unsurpassed financial strength ($1.87 billion in cash and an unsecured revolving credit line of $575 million at yearend 2003), continued low costs per Available Seat Mile, leading Customer Satisfaction record, and superb Employee esprit de corps to prevail over the 2004 uncertainties with respect to: fuel price levels (we are over 80 percent hedged for the year with prices capped at approximately $24 per barrel of crude oil); the rate of U.S. economic recovery and attendant expansion of Customer demand; a potential substantial expansion in capacity by competitive air carriers; and any exogenous events adversely affecting the domestic airline industry. In May of 2004, we will commence air service to Philadelphia, the largest metropolitan area in the U.S. not now served, directly or indirectly, by Southwest. We have also announced that in light of Southwest s strong cash position, investment-grade balance sheet, and desire to maximize Employee-Shareholder and non-employee- Shareholder value that Southwest intends to use the very significant present and anticipated proceeds from the exercise of our outstanding stock options for the repurchase, from time to time, of up to $300 million of our common stock in the open market. For more than three decades, the wisdom, farsightedness, goodwill, and camaraderie of our People have produced a remarkable airline providing remarkable psychic and financial rewards for all of our Employees. We thank them for their understanding and their goodness, which have produced greatness for Southwest and for them. January 20, 2004 Most sincerely,
Southwest Airlines Co. 2003 Annual Report 3 Herbert D. Kelleher, Chairman of the Board Herb was named to Secretary of Homeland Security Tom Ridge s advisory panel in 2003. James F. Parker, Vice Chairman & CEO Jim was named one of two Business People of the Year by Dallas Business Journal; the other was Colleen Barrett. Colleen C. Barrett, President & COO Colleen was named one of the 50 Most Powerful Women in Business by FORTUNE magazine two years running.
4 Southwest Airlines Co. 2003 Annual Report SPREADING OUR WINGS In June 2003, Southwest Airlines announced that our current and future fleet of Boeing 737-700s will be outfitted with fuel-saving, performance-enhancing Blended Winglets. We unveiled the fleet s first jet with winglets in ceremonies in Austin, Dallas, and Houston representing our original Texas Triangle destinations in 1971. These sleek, colorful appendages on the wings of our handsome Canyon Blue jets give the fleet a distinctive, technologically advanced look and feel.
Southwest Airlines Co. 2003 Annual Report 5 2003 proved to be another perilous year for the airline industry. With the Iraq war, severe acute respiratory syndrome (SARS), a weak economy, high energy costs, and terrorism-related concerns, the major airlines continue to report billions in losses and struggle for survival. Since September 11, 2001, major airlines have cut capacity, slashed jobs, and scrambled to reduce their costs to avoid bankruptcy and compete in an industry that is forever changed. Two major airlines have already filed bankruptcy, and other smaller carriers have ceased operations entirely. As a result of the dire financial condition of our major airline competitors, exacerbated by the war in Iraq, the government provided substantial cash payments to the airline industry under the Emergency Wartime Supplemental Appropriations Act. The government also waived the requirement that security fees be collected on airline tickets issued from June 1 to September 30, 2003. Despite these difficult challenges, we reported our 31st consecutive annual profit in 2003 because of our low operating costs and superb People. Southwest s long profitability record is unmatched in the airline industry, and we are also the only major airline to post a profit in every quarter following the September 11 terrorist attacks. While the airline industry, as a whole, reported losses for the third straight year in 2003, our profits were up significantly from 2002, even excluding the favorable impact from the $271 million federal grant. Because we were financially prepared, we were able to persevere through these difficult times and build a stronger Southwest. Instead of significant capacity reductions, Southwest invested in our future. We took care of our People, providing pay rate increases and Profitsharing rather than furloughs and wage concessions. We added airplanes, expanded airports, and invested in facilities, equipment, and automation to enhance our Customers experience and prepare us for future growth. Although we cannot predict what external, uncontrollable events could impact us in 2004, it seems that the worst could finally be behind us. The downward revenue trends prior to and shortly following the Iraq war have improved, albeit gradually. Although the industry has planned for significant capacity increases in 2004, we are confident in our future and believe we are uniquely positioned for growth. Low Costs Historically, Southwest has enjoyed a significant cost advantage compared to the legacy carriers. That advantage has been somewhat diminished as those carriers have reduced their labor costs and improved their work rules through either voluntary concessions or the bankruptcy process. In addition, there are now a number of new, rapidly growing carriers with costs roughly comparable to those of Southwest Airlines. The Employees of Southwest have always understood that we are profitable, growing, and successful because of our competitive cost advantage. Although our costs remain low, we are not satisfied with the inflation we began to experience in our cost structure during second half 2003 and are aggressively implementing various measures to improve our productivity. Effective December 15, 2003, Southwest no longer pays a commission on flights booked by traditional travel agencies, which will reduce operating costs by approximately $40 million annually. In February 2004, we will consolidate our reservations operations from nine into six Reservations Centers. We will incur restructuring charges of an estimated $20 million in first quarter 2004 and expect ongoing cost savings to exceed that amount each year. As a result of these and many other measures, cost pressures should ease in second half 2004. Our Employees are motivated and innovative, and we are confident that our People will continue to find and embrace faster and better ways of running our business. While a lot of factors contribute to Southwest s historic low cost advantage, the primary driver is the productivity and Southwest Spirit of our People. We are devoted to the low-fare, point-to-point market niche and have a highly efficient route structure. This market focus allows us to operate a single aircraft type, the Boeing 737. Commonality of fleet significantly simplifies our scheduling, operations, and maintenance and, therefore, lowers cost. We consistently run an ontime operation, with few mishandled bags 8.96 9.43 8.51 8.02 8.27 9.5 9.0 8.5 8.0 7.5 7.0 7.48 7.73 7.54 7.41 7.60 7.8 7.6 7.4 7.2 7.0 52,855 59,910 65,295 68,887 71,790 70 60 50 40 30 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 Operating Revenues Per Available Seat Mile Operating Expenses Per Available Seat Mile Available Seat Miles (in millions)
6 Southwest Airlines Co. 2003 Annual Report CHICAGO MIDWAY BALTIMORE/ WASHINGTON INTERNATIONAL HOUSTON HOBBY Recent renovations to our Chicago Midway, Baltimore/Washington International, and Houston Hobby airports have resulted in stunning new environments for our colorful Southwest counters and gate areas. Not only are these downtown airports more convenient than their big airport counterparts, they are now calm, comfortable, and traveler-friendly. Southwest offers our Customers a welcome oasis from a workaday world, coast-to-coast and border-to-border.
Southwest Airlines Co. 2003 Annual Report 7 and cancellations. Our fleet is young and well-maintained, which also allows us to avoid excessive mechanical delays. Where available, we favor alternative airports in major U.S. cities, avoiding congestion in competitors hubs, which keeps our planes off the ground and in the air where they are making money. We have a very strong low-fare brand, which draws Customers to us directly and results in very low distribution costs. In 2003, approximately 54 percent of passenger revenues were derived through the Company s web site at southwest.com and only 16 percent were booked through travel agents. Going forward, our distribution costs will be even lower due to the consolidation of our reservations operations and the elimination of traditional travel agency commissions. Southwest also has a successful hedging program, which saved us $171 million in jet fuel costs during 2003. We are also well protected in 2004 and 2005 with over 80 and 70 percent, respectively, of our anticipated fuel requirements hedged with prices capped at approximately $24 per barrel of crude oil. Low Fares Low fares has been our philosophy since day one every seat, every flight, every day. Since 1971, we have fought to keep our costs low so that we could make flying affordable instead of a luxury for a few. As we have grown and introduced Southwest fares to the new communities we serve, more of our Customers understand they can always rely on us for a low fare. Although every carrier has been a low-fare carrier since September 11, we are the only airline that has offered low fares profitably and consistently for 32+ years. Our Employees remain dedicated to spreading low fares and their Legendary Customer Service across America. Bringing low fares to Americans is not just our business, it s our passion. Legendary Customer Service Our Employees are widely recognized for their Southwest Spirit and caring hearts. Because we have earned a reputation as a great place to work, we attract and hire the best applicants. According to the April 2003 issue of FORTUNE, Southwest is an employer of choice among college students. Once we hire someone, we train, develop, and provide the support they need to succeed. We trust our Employees, and we empower them to effectively make decisions to perform their jobs in a challenging industry. Our Employees genuinely care about our Company, our Customers, and the communities we serve. They have had to endure constant change and stress since September 11, 2001, while adapting to complicated security measures and procedures. We have deployed new technologies at our airports and dramatically changed the way we operate our business. Despite these difficult operating conditions, our People never lost their compassion, caring hearts, or desire to deliver the best Customer Service in the industry. Southwest had the best annual Customer complaint record of all carriers for the 13th straight year based on Customer complaints reported in the U.S. Department of Transportation s (D.O.T.) Air Travel Consumer Report. Southwest also had the best systemwide ontime performance record of any Major U.S. airline for the full year 2003 as reported in the D.O.T. s Air Travel Consumer Report. (A Major airline is defined as having annual operating revenue of $1 billion or more.) During 2003, The Wall Street Journal reported Southwest ranked first among airlines for the highest Customer Service Satisfaction, according to a survey by the American Customer Satisfaction Index. In 2003, Southwest was named Best Domestic Airline of the Year by Travel Weekly and Airline of the Year by Air Transport World magazine. Southwest is also consistently recognized by FORTUNE as one of America s Most Admired Companies and America s most admired airline. Our Employees are also wonderful stewards in the communities we serve. Southwest is committed to doing the right thing, which is why giving back to the communities we serve and positively contributing to the environment is simply the way we do business. As a result of our caring and altruistic Employees, Southwest was included in Global Finance magazine s January 2004 Experts List of the World s Most Socially Responsible Companies. Southwest was also listed again in Business Ethics magazine s 100 Best Corporate Citizens and again recognized for having the best reputation among U.S. airlines in a 2003 study conducted by Harris Interactive Inc. and the Reputation Institute. In addition, Southwest was the first U.S. airline to be awarded the Corporate Conscience Award for Community Positive Impact in October 2003. Frequent Flights Southwest offers lots of flights to the cities we serve and continued to increase flights in 2003. We have approximately 2,800 daily frequencies to 59 airports. Our high frequencies and expansive route system offer our Customers convenience and reliability with lots of options to get where they want to go, when they want to get there. As a result of the combination of low fares, high frequencies, and our friendly Customer Service, we dominate the majority of the markets we serve. We consistently rank first in market share in approximately 90 percent of our top 100 city-pair markets and, in the aggregate, hold around 65 percent of the total market share in those markets. Although our revenues have been soft since September 11, 2001, our market share has increased in many of our markets as most of our major competitors have been forced to shrink
8 Southwest Airlines Co. 2003 Annual Report PHILADELPHIA FREEDOM In October 2003, Southwest announced service to Philadelphia, the city that freedom built, beginning in May 2004. Philadelphia was once the home of local legend and Southwest Chairman Herb Kelleher (center left), whose triumphant return to his boyhood home gives all Philadelphians the Freedom to Fly. Philadelphia is also the home of the original Ronald McDonald House (lower left), the primary charity of Southwest Airlines.
Southwest Airlines Co. 2003 Annual Report 9 their operations. For example, as of second quarter 2003 (the latest information available), we have a 48 percent market share in Chicago Midway; 44 percent in Baltimore; 36 percent in Las Vegas; and 36 percent in Phoenix. We also have a 74 percent intra-texas market share; 71 percent intra-california; and 42 percent intra-florida. Rapid Rewards In addition to our low fares and convenient flight schedule, our frequent flyers are generously rewarded with free trips through our Rapid Rewards program. Rapid Rewards allows Customers to receive a roundtrip award valid for travel anywhere Southwest flies by simply flying eight roundtrips or earning 16 credits (a one-way ticket equals one credit) within 12 consecutive months. There are no seat restrictions and very few blackout dates for awards travel; therefore, Members can use their award to fly virtually anytime to any Southwest destination. Rapid Rewards awards are also fully transferable. Inside Flyer magazine recognized the generosity and simplicity of our Rapid Rewards program with its Freddie Awards for Best Customer Service, Best Award Redemption, and Best Bonus Promotion among all frequent flyer programs. Rapid Rewards Members can also receive Rapid Rewards credits when doing business with our Preferred Partners (Alamo, American Express, Budget, Diners Club, Dollar, Hertz, Earthlink, Nextel, Hilton, Hyatt, Marriott, La Quinta, and Choice brand hotels) as well as through the use of the Southwest Airlines Rapid Rewards Bank One Visa credit card. Strong Financials Our Chairman and Co-founder, Herb Kelleher, has always taught us to manage our Company in good times so that we are ready for bad times. As a result of this philosophy, we have the strongest financial position in the industry, and we were prepared for the devastating aftermath of September 11, 2001. We operate in an industry that is cyclical, energy intensive, labor intensive, and capital intensive. Our operating costs are largely fixed, and our operations are subject to federal oversight, weather conditions, and natural disasters. Our industry is also highly competitive. Consequently, we must always be financially prepared for the worst. Since September 11, 2001, we have taken the necessary steps to protect and even strengthen our balance sheet and liquidity. At the end of 2003, we had $1.87 billion in cash on hand, a fully available bank revolving credit facility of $575 million, unmortgaged assets of over $5 billion, and debt to total capital of less than 40 percent, including leases as debt. We are the only airline with an investment-grade credit rating. We have adequate access to the capital markets and have strengthened our financial position during the post-september 11 period; therefore, we are well poised to take advantage of growth opportunities or face further adversities. In consideration of our strong financial and cash flow position and our desire to maximize Employee-Shareholder and non-employee-shareholder value, we recently announced that we intend to use a portion of the very significant present and anticipated proceeds from the exercise of Employee stock options toward the repurchase of up to $300 million of our common stock from time to time in the open market. Growth Opportunities Steady, conservative growth during the recessionary environment since the terrorist attacks has enabled Southwest to restore our operations, strengthen our balance sheet, and maintain our profitability. We grew our annual capacity by just over four percent in 2003 and over five percent in 2002. Since September 11, 2001, we have added 30 net aircraft. The airline industry, on the other hand, has reduced domestic capacity by 15 to 20 percent. As a result of our decision to cautiously grow rather than reduce capacity, Southwest topped the monthly domestic originating passenger rankings for the first time in May 2003. Also Southwest is the largest carrier based on scheduled domestic departures. With the exception of Norfolk, which was planned prior to the terrorist attacks, there have been no new cities since September 11, 2001. Instead, we added new city-pair routings and increased existing $474 $625* $511 $241 $442 $600 $500 $400 $300 $200 $100 2,550 2,700 2,800 2,800 2,800 2,800.90.95.95.83.84.88 1.0 2,600.78.75 2,400 2,200.52.50 2,000.14.25 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 LUV ALK DAL UAL AWA AMR * U CAL NWAC Net Income (in millions) * Excludes cumulative effect of change in accounting principle of $22 million Average Daily Departures Customer Service (Complaints per 100,000 Customers boarded) For the year ending December 31, 2003 * Excludes American Eagle Airlines
10 Southwest Airlines Co. 2003 Annual Report FREEDOM FIGHTERS The People of Southwest Airlines are our most valuable asset. It is their friendliness, Customer caring, and relentless resourcefulness that have helped make Southwest one of the world s most successful airlines. We are not a Company of planes; we are a Company of People People willing to fight for your right to fly.
Southwest Airlines Co. 2003 Annual Report 11 service in many markets, particularly in Baltimore/Washington and Chicago Midway. We celebrated our tenth anniversary in Baltimore/Washington in 2003, now our third largest market in terms of daily departures. We have 161 daily nonstop flights from Baltimore/Washington, including coast-to-coast service to Los Angeles, San Jose, and San Diego. Chicago Midway is now our fifth largest city in terms of daily departures with 134. In addition to recently expanding airport facilities at Baltimore/Washington and Chicago Midway, we have major expansion projects at Fort Lauderdale, Houston Hobby, Las Vegas, Long Island/Islip, Oakland, Orange County, Orlando, Phoenix, and Tampa Bay. With the worst of times hopefully behind us, we are prepared for accelerated growth. As a result of significant penetration by Southwest and other low-fare carriers and the ability for Customers to easily shop for low fares on the Internet, more Americans than ever realize that they do not have to pay high fares. Given the weak financial condition of the industry, we are uniquely positioned to meet the increased demand for low fares. After all, profitably offering low fares is what we do best! As a result of our improved longterm outlook and numerous opportunities to grow, we have stepped up our growth rate and currently expect to increase capacity almost eight percent in 2004 and over ten percent in 2005. In total, we have just under 400 Boeing 737 aircraft on either firm order, option, or purchase rights with The Boeing Company from 2004 through 2012, which results in an annualized growth rate during this period of roughly eight percent. We are well positioned to grow our traditional low-fare, point-to-point market niche and are excited to bring the Freedom to Fly to Philadelphia in May 2004. From Philadelphia, we will initially begin service to Chicago Midway, Las Vegas, Orlando, Phoenix, Providence, and Tampa Bay. Airport Automation Our People have done a wonderful job of responding to the multitude of complex security changes since the September 11, 2001, terrorist attacks. In fact, our Chairman was recently appointed to the Private Sector Senior Advisory Committee, a subcommittee of the Homeland Security Advisory Council. Although these new requirements initially presented challenges and longer checkin times and lines for our Customers, the checkin times are back to normal for our Customers and, in many ways, the airport experience has been improved. To facilitate the many new security requirements, we have streamlined our airport operations with automation. We implemented computer-generated baggage tags to electronically capture bags checked by Customers. We then introduced computer-generated Automated Boarding Passes from multiple points at the airport. This allows us to identify the Customer by name for boarding purposes and allows the Customer a more convenient checkin at airports through standing in fewer lines. We also implemented self-service boarding pass kiosks, or RAPID CHECK-IN, to allow our Customers plenty of options to acquire boarding passes and alleviate checkin lines at ticket and gate counters. As a result of this technology, we recently installed gate reconciliation devices at our airports to speed the boarding process. In 2004, Customers will be able to check bags using our RAPID CHECK-IN kiosks and will be able to obtain their transfer boarding passes at the time of checkin. We will also offer Customer checkin and boarding passes on southwest.com. All-Jet Fleet At the end of 2003, Southwest operated an all-coach, all-boeing 737 fleet. All of our future orders, options, and purchase rights with The Boeing Company for 2004 through 2012 are for B737-700s. The average age of our young fleet is less than ten years. As the -700 model is our future, we are in the process of retiring our -200 fleet over the next two years with 18 and five retirements scheduled in 2004 and 2005, respectively. Since 2001, we have been renewing the interior and exterior of our fleet, including leather-covered seats. Beginning in October 2004, all of our -700s are expected to be delivered with Blended Winglets, and we are in the process of retrofitting our existing -700s with winglets through early 2005. The addition of these wing enhancements will extend the range of the aircraft, save fuel, lower engine maintenance costs, and reduce takeoff noise. 11:10 11:18 11:10 11:12 11:09 11:20 11:15 11:10 11:05 11:00 312 344 355 375 388 400 300 200 100 Type Firm Orders 47 28 Options Purchase Rights Total 2004 2005 2006 2007 2008 22 25 6 6 12 9 25 47 34 34 54 51 2009-2012 20 20 177 177 Total 128 52 217 397 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 Aircraft Utilization (hours and minutes per day) Fleet Size (at yearend) Boeing 737-700 Firm Orders and Options
12 Southwest Airlines Co. 2003 Annual Report Oakland (San Francisco Area) Sacramento Portland San Jose (San Francisco Area) Seattle/ Tacoma Spokane Reno/Tahoe Las Vegas Burbank Los Angeles (LAX) Ontario Orange County San Diego Boise (Palm Springs Area) Southwest System Map Service to Philadelphia starts May 9, 2004 Salt Lake City Phoenix Tucson Albuquerque (Santa Fe Area) Amarillo Lubbock Omaha Oklahoma City El Paso Midland/ Dallas Odessa (Love Field) Austin San Antonio Corpus Christi Tulsa Kansas City St. Louis Little Rock Chicago (Midway) Houston (Hobby & Intercontinental) Harlingen/South Padre Island Detroit Nashville Birmingham New Orleans Cleveland Columbus Indianapolis Jackson Louisville Buffalo/ Niagara Falls Tampa Bay Albany Philadelphia Baltimore/ Washington (BWI) Raleigh-Durham Jacksonville Orlando (Miami Area) Norfolk West Palm Beach Ft. Lauderdale Manchester Providence Hartford/Springfield Long Island/Islip (D.C. Area) (Southern Virginia) (Boston Area) (Boston Area) Other Carriers 35% California 18% East 29% Southwest 65% Remaining West 26% Midwest 15% Heartland 12% Southwest s Market Share (Southwest s top 100 city-pair markets based on passengers carried) Southwest s Capacity By Region 183 185 200 83 86 114 122 130 134 143 161 175 150 125 100 75 50 San Diego Nashville Los Angeles Oakland Dallas Love Chicago Midway Houston Hobby Baltimore/ Washington Phoenix Las Vegas Southwest s Top Ten Airports Daily Departures
Southwest Airlines Co. 2003 Annual Report 13 QUARTERLY FINANCIAL DATA (UNAUDITED) THREE MONTHS ENDED (In millions, except per share amounts) MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 2003 Operating revenues $1,351 $1,515 $1,553 $1,517 Operating income 46 140 185 111 Income before income taxes 39 397 171 101 Net income 24 246 106 66 Net income per share, basic.03.32.14.08 Net income per share, diluted.03.30.13.08 2002 Operating revenues $1,257 $1,473 $1,391 $1,401 Operating income 49 189 91 88 Income before income taxes 35 169 124 64 Net income 21 102 75 42 Net income per share, basic.03.13.10.05 Net income per share, diluted.03.13.09.05 COMMON STOCK PRICE RANGES AND DIVIDENDS Southwest s common stock is listed on the New York Stock Exchange and is traded under the symbol LUV. The high and low sales prices of the common stock on the Composite Tape and the quarterly dividends per share were: PERIOD DIVIDENDS HIGH LOW 2003 1st Quarter $.0045 $15.33 $11.72 2nd Quarter.0045 17.70 14.09 3rd Quarter.0045 18.99 15.86 4th Quarter.0045 19.69 15.30 2002 1st Quarter $.0045 $22.00 $17.17 2nd Quarter.0045 19.35 14.85 3rd Quarter.0045 16.08 10.90 4th Quarter.0045 16.70 11.23 $5,650 $5,555 $5,522 $4,736 $5,937 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 69.0% 70.5% 68.1% 65.9% 66.8% 75% 70% 65% 60% 55% 50% 36,479 42,215 44,494 45,392 47,943 50 40 30 20 10 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003 Operating Revenue (in millions) Passenger Load Factor Revenue Passenger Miles (in millions)
14 Southwest Airlines Co. 2003 Annual Report TEN-YEAR SUMMARY SELECTED CONSOLIDATED FINANCIAL DATA (Dollars in millions, except per share amounts) 2003 (4) 2002 (3) 2001 (3) 2000 Operating revenues: Passenger (2) $ 5,741 $ 5,341 $ 5,379 $ 5,468 Freight 94 85 91 111 Other (2) 102 96 85 71 Total operating revenues 5,937 5,522 5,555 5,650 Operating expenses 5,454 5,105 4,924 4,628 Operating income 483 417 631 1,022 Other expenses (income), net (225) 24 (197) 4 Income before income taxes 708 393 828 1,018 Provision for income taxes 266 152 317 392 Net income (1) $ 442 $ 241 $ 511 $ 626 Net income per share, basic (1) $.56 $.31 $.67 $.84 Net income per share, diluted (1) $.54 $.30 $.63 $.79 Cash dividends per common share $.0180 $.0180 $.0180 $.0148 Total assets $ 9,878 $ 8,954 $ 8,997 $ 6,670 Long-term debt less current maturities $ 1,332 $ 1,553 $ 1,327 $ 761 Stockholders equity $ 5,052 $ 4,422 $ 4,014 $ 3,451 CONSOLIDATED FINANCIAL RATIOS Return on average total assets 4.7% 2.7% 6.5% 10.1% Return on average stockholders equity 9.3% 5.7% 13.7% 19.9% CONSOLIDATED OPERATING STATISTICS Revenue passengers carried 65,673,945 63,045,988 64,446,773 63,678,261 RPMs (000s) 47,943,066 45,391,903 44,493,916 42,215,162 ASMs (000s) 71,790,425 68,886,546 65,295,290 59,909,965 Passenger load factor 66.8% 65.9% 68.1% 70.5% Average length of passenger haul 730 720 690 663 Trips flown 949,882 947,331 940,426 903,754 Average passenger fare (2) $87.42 $84.72 $83.46 $85.87 Passenger revenue yield per RPM (2) 11.97 11.77 12.09 12.95 Operating revenue yield per ASM 8.27 8.02 8.51 9.43 Operating expenses per ASM 7.60 7.41 7.54 7.73 Operating expenses per ASM, excluding fuel 6.44 6.30 6.36 6.38 Fuel cost per gallon (average) 72.3 68.0 70.9 78.7 Number of Employees at yearend 32,847 33,705 31,580 29, 274 Size of fleet at yearend (5) 388 375 355 344 (1) Before cumulative effect of change in accounting principle (2) Includes effect of reclassification of revenue reported in 1999 through 1995 related to sale of flight segment credits from Other to Passenger due to the accounting change implemented in 2000 (3) Certain figures in 2001 and 2002 include special items related to the September 11, 2001, terrorist attacks and Stabilization Act grant (4) Certain figures in 2003 include special items related to the Wartime Act grant (5) Includes leased aircraft (6) Includes certain estimates for Morris Air Corporation, acquired by the Company in 1994
Southwest Airlines Co. 2003 Annual Report 15 1999 1998 1997 1996 1995 1994 $ 4,563 $ 4,010 $ 3,670 $ 3,285 $ 2,768 $ 2,498 103 99 95 80 66 54 70 55 52 41 39 40 4,736 4,164 3,817 3,406 2,873 2,592 3,954 3,480 3, 293 3, 055 2,559 2,275 782 684 524 351 314 317 8 (21) 7 10 8 18 774 705 517 341 306 299 299 272 199 134 123 120 $ 475 $ 433 $ 218 $ 207 $ 183 $ 179 $.63 $.58 $.43 $.28 $.25 $.25 $.59 $.55 $.41 $.27 $.24 $.24 $.0143 $.0126 $.0098 $.0087 $.0079 $.0079 $ 5,654 $ 4,716 $ 4,246 $ 3,723 $ 3,256 $ 2,823 $ 872 $ 623 $ 628 $ 650 $ 661 $ 583 $ 2,836 $ 2,398 $ 2,009 $ 1,648 $ 1,427 $ 1,239 9.2% 9.7% 8.0% 5.9% 6.0% 6.6% 18.1% 19.7% 17.4% 13.5% 13.7% 15.6% 57,500, 213 52,586,400 50, 399,960 49,621,504 44,785,573 42,742,602 (6) 36,479,322 31,419,110 28,355,169 27,083,483 23,327,804 21,611,266 52,855,467 47, 543,515 44, 487, 496 40,727, 495 36,180, 001 32,123,974 69.0% 66.1% 63.7% 66.5% 64.5% 67.3% 634 597 563 546 521 506 846,823 806,822 786,288 748,634 685,524 624,476 $79.35 $76.26 $72.81 $66.20 $61.80 $58.44 12.51 12.76 12.94 12.13 11.86 11.56 8.96 8.76 8.58 8.36 7.94 8.07 7.48 7.32 7.40 7.50 7.07 7.08 6.55 6.50 6. 29 6.31 6.06 6.09 52.7 45.7 62.5 65.5 55.2 53.9 27,653 25,844 23,974 22,944 19,933 16,818 312 280 261 243 224 199
16 Southwest Airlines Co. 2003 Annual Report CORPORATE DATA TRANSFER AGENT AND REGISTRAR Registered shareholder inquiries regarding stock transfers, address changes, lost stock certificates, dividend payments, or account consolidation should be directed to: Continental Stock Transfer & Trust Company 17 Battery Place New York, New York 10004 (212) 509-4000 STOCK EXCHANGE LISTING New York Stock Exchange Ticker Symbol: LUV INDEPENDENT AUDITORS Ernst & Young LLP Dallas, Texas GENERAL OFFICES P.O. Box 36611 Dallas, Texas 75235-1611 ANNUAL MEETING The Annual Meeting of Shareholders of Southwest Airlines Co. will be held at 10:00 a.m. on May 19, 2004, at the Southwest Airlines Corporate Headquarters, 2702 Love Field Drive, Dallas, Texas. FINANCIAL INFORMATION A copy of the Company s Annual Report on Form 10-K as filed with the U.S. Securities and Exchange Commission (SEC) and other financial information can be found on Southwest s web site (southwest.com) or may be obtained without charge by writing or calling: Southwest Airlines Co. Investor Relations P.O. Box 36611 Dallas, Texas 75235-1611 Telephone (214) 792-4908 DIRECTORS COLLEEN C. BARRETT President and Chief Operating Officer Southwest Airlines Co., Dallas, Texas LOUIS CALDERA President of The University of New Mexico Albuquerque, New Mexico; Audit and Nominating and Corporate Governance Committees C. WEBB CROCKETT Attorney, Fennemore Craig, Attorneys at Law, Phoenix, Arizona; Compensation and Nominating and Corporate Governance Committees WILLIAM H. CUNNINGHAM, Ph.D. James L. Bayless Professor of Marketing University of Texas School of Business Former Chancellor of The University of Texas System, Austin, Texas; Audit (Chairman) and Nominating and Corporate Governance Committees WILLIAM P. HOBBY Chairman of the Board, Hobby Communications, L.L.C.; Former Lieutenant Governor of Texas; Houston, Texas; Audit, Compensation (Chairman), and Nominating and Corporate Governance Committees TRAVIS C. JOHNSON Attorney at Law, El Paso, Texas; Audit, Executive, and Nominating and Corporate Governance Committees HERBERT D. KELLEHER Chairman of the Board, Southwest Airlines Co., Dallas, Texas; Executive Committee ROLLIN W. KING Retired, Dallas, Texas; Audit, Executive, and Nominating and Corporate Governance Committees NANCY LOEFFLER Longtime advocate of volunteerism San Antonio, Texas JOHN T. MONTFORD President, External Affairs, SBC Southwest, a division of SBC Communications, Inc., San Antonio, Texas; Audit and Nominating and Corporate Governance Committees JUNE M. MORRIS Founder and former Chief Executive Officer of Morris Air Corporation, Salt Lake City, Utah; Audit, Compensation, and Nominating and Corporate Governance Committees JAMES F. PARKER Vice Chairman and Chief Executive Officer of Southwest Airlines Co., Dallas, Texas OFFICERS JAMES F. PARKER* Vice Chairman and Chief Executive Officer COLLEEN C. BARRETT* President and Chief Operating Officer Corporate Secretary DONNA D. CONOVER* Executive Vice President Customer Service GARY C. KELLY* Executive Vice President and Chief Financial Officer JAMES C. WIMBERLY* Executive Vice President and Chief of Operations JOYCE C. ROGGE* Senior Vice President Marketing DEBORAH ACKERMAN Vice President General Counsel BEVERLY CARMICHAEL Vice President People Department GREGORY N. CRUM Vice President Flight Operations GINGER C. HARDAGE Vice President Corporate Communications ROBERT E. JORDAN Vice President Technology CAMILLE T. KEITH Vice President Special Marketing DARYL KRAUSE Vice President Provisioning KEVIN M. KRONE Vice President Interactive Marketing PETE MCGLADE Vice President Schedule Planning BOB MONTGOMERY Vice President Properties and Facilities ROB MYRBEN Vice President Fuel RON RICKS* Vice President Governmental Affairs DAVE RIDLEY* Vice President Ground Operations JAMES A. RUPPEL Vice President Customer Relations and Rapid Rewards RAY SEARS Vice President Purchasing JIM SOKOL Vice President Maintenance and Engineering KEITH L. TAYLOR Vice President Revenue Management ELLEN TORBERT Vice President Reservations MICHAEL G. VAN DE VEN Vice President Financial Planning and Analysis TAMMYE WALKER-JONES Vice President Inflight GREG WELLS Vice President Safety, Security, and Flight Dispatch STEVEN P. WHALEY Controller LAURA H. WRIGHT Vice President Finance and Treasurer *Member of Executive Planning Committee
One of the interesting results of this financial crisis is that some airlines have found ways to operate far more efficiently and cheaply. The ideas aren t really new many are things Southwest has been doing for years. USA Today, January 9, 2003 The top ten won the business world s regard by refocusing attention where it counts the most: on customers and employees. FORTUNE magazine, in its annual listing of America s Most Admired Companies, in which Southwest finished second, February 19, 2003 Rather than starting their own, If Delta and United really want to invest in a discount airline, there s a better way: Buy some Southwest stock. Washington Post columnist Steven Pearlstein, in an article titled Airline Recovery Plans Fly in the Face of Reason, March 25, 2003 Unlike other carriers, Southwest has lured plenty of Customers without partnering with travel Web sites Expedia, Travelocity, and Orbitz. Their Customers seek them out, which is tremendous, said Paul Berliner, an industry consultant. I mean, my goodness, that s what you dream about. San Jose Mercury News, May 8, 2003 Many carriers, new and old, are trying to emulate Southwest s low-cost, no-frills formula. And there has been a nearly perfect inverse correlation between declining traffic for old-line carriers and increasing traffic at the low-cost carriers of which Southwest is the progenitor. The Wall Street Journal, July 24, 2003 Let s see Southwest pays Employees well and makes it clear through actions rather than managementspeak that it appreciates and trusts its workers. And the company succeeds where others fail. What a shock. The San Francisco Chronicle, August 13, 2003 It s becoming as predictable as death and taxes: Southwest Airlines reported its 50th-consecutive quarterly profit. Today in the Sky, USA Today, October 22, 2003 Southwest Airlines may only be the nation s sixth largest airline, but it doesn t act like No. 6. In many ways, it may be No. 1. The grandfather of the low-cost airline has set the pace and provided the model for the latest crop of low-fare carriers. Southwest s financial superlatives in these days of airline bankruptcies are of chest-pounding stuff. Airline Financial News, December 4, 2003 SOUTHWEST AIRLINES CO. P.O. Box 36611 Dallas, Texas 75235-1611 214.792.4000 1.800.I.FLY.SWA southwest.com
(Mark One) [X] SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2003 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File No. 1-7259 SOUTHWEST AIRLINES CO. (Exact name of registrant as specified in its charter) TEXAS 74-1563240 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) P.O. Box 36611 Dallas, Texas 75235-1611 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (214) 792-4000 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Name of Each Exchange Title of Each Class on Which Registered Common Stock ($1.00 par value) New York Stock Exchange, Inc. Common Share Purchase Rights New York Stock Exchange, Inc. SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ] The aggregate market value of the Common Stock held by non-affiliates of the registrant was approximately $13,309,000,000, computed by reference to the closing sale price of the stock on the New York Stock Exchange on June 30, 2003, the last trading day of the registrant s most recently completed second fiscal quarter. Number of shares of Common Stock outstanding as of the close of business on December 31, 2003: 789,390,678 shares DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement for Annual Meeting of Shareholders, May 19, 2004: PART III
PART I Item 1. Business Description of Business Southwest Airlines Co. ( Southwest ) is a major domestic airline that provides predominantly shorthaul, high-frequency, point-to-point, low-fare service. Southwest was incorporated in Texas in 1967 and commenced Customer Service on June 18, 1971 with three Boeing 737 aircraft serving three Texas cities - Dallas, Houston, and San Antonio. At year-end 2003, Southwest operated 388 Boeing 737 aircraft and provided service to 59 airports in 58 cities in 30 states throughout the United States. Southwest Airlines topped the monthly domestic passenger traffic rankings for the first time in May 2003. Based on monthly data from May through August 2003 (the latest available data), Southwest Airlines is the largest carrier in the United States based on originating domestic passengers boarded and scheduled domestic departures. The Company recently announced that it intends to begin service to Philadelphia in May 2004. One of Southwest s competitive strengths is its low operating costs. Southwest has the lowest costs, adjusted for stage length, on a per mile basis, of all of the major airlines. Among the factors that contribute to its low cost structure are a single aircraft type, an efficient, high-utilization, point-to-point route structure, and hardworking, innovative, and highly productive Employees. The business of the Company is somewhat seasonal. Quarterly operating income and, to a lesser extent, revenues tend to be lower in the first quarter (January 1 - March 31) and fourth quarter (October 1 - December 31) of most years. Southwest s filings with the Securities and Exchange Commission ( SEC ), including its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are accessible free of charge at www.southwest.com. Fuel The cost of fuel is an item having significant impact on the Company's operating results. The Company's average cost of jet fuel, net of hedging gains, over the past five years was as follows: Year Cost (Millions) Average Cost per Gallon Percent of Operating Expenses 1999 $492 $.53 12.5% 2000 $804 $.79 17.4% 2001 $771 $.71 15.6% 2002 $762 $.68 14.9% 2003 $830 $.72 15.2% From October 1, 2003 through December 31, 2003, the average cost per gallon was $.74. See Management s Discussion and Analysis of Financial Condition and Results of Operations for a discussion of Southwest s fuel hedging activities. Regulation Economic. The Dallas Love Field section of the International Air Transportation Competition Act of 1979, as amended in 1997 (commonly known as the Wright Amendment ), as it affects Southwest's scheduled service, provides that no common carrier may provide scheduled passenger air transportation for compensation between Love Field and one or more points outside Texas, except that an air carrier may transport individuals by air on a flight between Love Field and one or more points within the states of
Alabama, Arkansas, Kansas, Louisiana, Mississippi, New Mexico, Oklahoma, and Texas if (a) "such air carrier does not offer or provide any through service or ticketing with another air carrier" and (b) "such air carrier does not offer for sale transportation to or from, and the flight or aircraft does not serve, any point which is outside any such states." The Wright Amendment does not restrict flights operated with aircraft having 56 or fewer passenger seats. The Wright Amendment does not restrict Southwest's intrastate Texas flights or its air service from points other than Love Field. The Department of Transportation ( DOT ) has significant regulatory jurisdiction over passenger airlines. Unless exempted, no air carrier may furnish air transportation over any route without a DOT certificate of public convenience and necessity, which does not confer either exclusive or proprietary rights. The Company's certificates are unlimited in duration and permit the Company to operate among any points within the United States, its territories and possessions, except as limited by the Wright Amendment, as do the certificates of all other U.S. carriers. DOT may revoke such certificates, in whole or in part, for intentional failure to comply with certain provisions of the U.S. Transportation Code, or any order or regulation issued thereunder or any term of such certificate; provided that, with respect to revocation, the certificate holder has first been advised of the alleged violation and fails to comply after being given a reasonable time to do so. DOT prescribes uniform disclosure standards regarding terms and conditions of carriage and prescribes that terms incorporated into the Contract of Carriage by reference are not binding upon passengers unless notice is given in accordance with its regulations. Safety. The Company and its third-party maintenance providers are subject to the jurisdiction of the Federal Aviation Administration ( FAA ) with respect to its aircraft maintenance and operations, including equipment, ground facilities, dispatch, communications, flight training personnel, and other matters affecting air safety. To ensure compliance with its regulations, the FAA requires airlines to obtain operating, airworthiness, and other certificates, which are subject to suspension or revocation for cause. The Company has obtained such certificates. The FAA, acting through its own powers or through the appropriate U. S. Attorney, also has the power to bring proceedings for the imposition and collection of fines for violation of the Federal Air Regulations. The Company is subject to various other federal, state, and local laws and regulations relating to occupational safety and health, including Occupational Safety and Health Administration (OSHA) and Food and Drug Administration (FDA) regulations. Security. On November 19, 2001, President Bush signed into law the Aviation and Transportation Security Act ( Security Act ). The Security Act generally provides for enhanced aviation security measures. The Security Act established a new Transportation Security Administration ( TSA ), which has recently been moved to the new Department of Homeland Security. The TSA assumed the aviation security functions previously residing in the FAA and assumed passenger screening contracts at U.S. airports on February 17, 2002. The TSA now provides for the screening of all passengers and property, which is performed by federal employees. Beginning February 1, 2002, a $2.50 per enplanement security fee is imposed on passengers (maximum of $5.00 per one-way trip). This fee was suspended by Congress from June 1 through September 30, 2003. Pursuant to authority granted to the TSA to impose additional fees on air carriers if necessary to cover additional federal aviation security costs, the TSA has imposed an annual Security Infrastructure Fee, which approximated $23 million for Southwest in 2002 and $18 million in 2003. This fee was also suspended by Congress from June 1 through September 30, 2003. Like the FAA, the TSA may impose and collect fines for violations of its regulations. Enhanced security measures have had, and will continue to have, a significant impact on the airport experience for passengers. While these security requirements have not impacted aircraft utilization, they have impacted our business. The Company has invested significantly in facilities, equipment, and technology to process Customers efficiently and restore the airport experience. The Company has implemented its